Fewer, Better Friends
“It is not the most intellectual of the species that survives; it is not the strongest that survives; but the species that survives is the one that is able best to adapt and adjust to the changing environment in which it finds itself”
Versions of Darwin’s famous quote have been used in books on everything from business strategy to politics and sport; the need to adapt is fashionable although the concept of change is often unpopular. Of course the world is always ‘changing’ and as a result we are called upon to ‘innovate’ and ‘adapt’ in all walks of life. Yet the rate of change in broker practice in the insurance market is currently happening at such a fast pace that unless underwriting firms adapt, irrespective of size, many may end up like the dodo.
Premium rates across multiple classes are known to be low at the moment. The continued softening appears to be at odds with the traditional market cycle, everyone is under pressure to write business for less with top line being the worrying focus for many in the market. This impact extends to brokers where the slice of cake available in commission is shrinking; as a result they are being forced to find ways to keep their revenues and profits up.
The way brokers are doing this is efficiency savings; spending less time on non-profitable relationships, less time wearing out shoe leather in Lloyd’s and less time offering small lines to underwriters. However the elephant in the room for underwriters is ‘facilities’. Berkshire Hathaway remodelled the broker/underwriter relationship three years ago by agreeing to write a fixed percentage of business that came in to Lloyd’s via a quota share facility - this is where underwriters pre-agree to write a percentage share of each risk following an approved leader’s terms. The quota share is essentially a market tracker for a particular class of business. This move by Berkshire threw down a gauntlet to the traditional underwriting model in the market, and companies have had to fight this duel.
This of course suits brokers; if they have a guaranteed line without even having to lift a finger then those insurers that join this party become their new best friends. Brokers now want fewer but better friends with whom they write more business. Whilst this isn’t new, the amount of business being put in to facilities, including quota shares, is increasing; on average 20% of business is now put in to facilities by the big brokers with this rising to over 40% in one household name broker.
Brokers are using market management services as an entry point for business relationships. These offer insurers a range of facilities from access to in-house data to quota shares. Increasingly popular is the ‘preferred panel’ which, upon winning a tender, place an insurer on a favoured shortlist of carriers who are shown each risk and given the option to write it before the rest of the market. Brokers are also investing heavily in managing general agents (MGA) geared to underwrite their business under delegated authorities.
The unpopularity with insurers is obvious, especially with quota shares where control over every individual risk evaporates. So how do insurers respond?
Some may choose to close-their-eyes, embrace the new world and position the writing of broker facilities at the heart of their strategy. However, history has not been kind to those firms in the past who have abrogated their underwriting responsibility. The state of the market currently would suggest that profit margins for those who do so will soon vanish. Shareholders and regulators may have something to say about that.
A more measured approach would be to blend facility underwriting in to the business strategy rather than subsuming it. Insurers might identify lines of business and geographies where facilities provide a complimentary channel of distribution; a shift towards portfolio underwriting whilst maintaining the technical skills and market profile to evaluate and price risks individually would suit many insurers.
The third option is to pass on facilities altogether. After all, the most important thing is individual broker relationships. If you have great relationships with the people you deal with in the market then they will show you their business. The problem with this is that brokers are under pressure. They might promise to show you all of the business they see, but probably won’t. Those individuals are being required to operate within the market management framework of their employing company. Increasingly they are only permitted to place risks in the open market once the ‘preferred’ insurers have had the first bite.
So what does all this evolution mean for insurers? Those with the best chance of surviving will be those that tackle three things: scale, distribution, strategy.
Insurers need to have the size to service multiple lines of business across a wide range of products. This includes having dual platform capabilities with both Lloyd’s and company platforms, something that accounts for a spate of recent acquisitions of Lloyd’s underwriting firms. In essence when brokers are choosing their fewer friends, you need to be more than just a pretty face, you need to have the depth to write serious business.
On top of this insurers need to take a long hard look at their distribution network and think where facilities can act as a useful conduit for business. They need to decide what type of facilities will help them grow profits, with the emphasis on trying to use them rather than seeing them as an inconvenience.
Finally insurers need to have a strategy for getting closer to not just individual brokers in each firm, but to the entire broking company. This is partly being done by the advent of relationship managers within underwriting firms and the advent of CRM systems that can maximise engagement with the big brokers of this world.
Brokers are evolving and underwriters will need to adapt. The dinosaurs have long left the market, but no species is too young to avoid extinction.